**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

**FORM 10-Q**

| **x**      | ** ** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)  OF THE SECURITIES EXCHANGE ACT OF 1934.**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
|------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|       |       | **For the quarterly period ended March 31, 2007.**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
|       |       | **OR**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| **o**      | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| ** ** | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| ** ** | ** ** | **For the transition period from                                               to                                             ** |

 

**Commission File Number: 1-11388**

**PLC SYSTEMS INC.**

(Exact Name of Registrant as Specified in Its Charter)

| **Yukon Territory, Canada**                |   | **04-3153858**                        |
|--------------------------------------------|--------|---------------------------------------|
| (State or Other Jurisdiction of            |   | (I.R.S. Employer  Identification No.) |
| Incorporation or Organization)             |   |                                  |
|                                       |   |                                  |
| **10 Forge Park, Franklin, Massachusetts** |   | **02038**                             |
| (Address of Principal Executive Offices)   |   | (Zip Code)                            |

 

Registrant’stelephone number, including area code: **(508) 541-8800**

Indicate by checkmark whether the registrant: (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.  **Yes  ****x   No ****o**

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” inRule 12b-2 of the Exchange Act.  (Checkone):

| Large accelerated filer o | Accelerated  filer o | Non-accelerated  filer x |
|--------------------------------|---------------------------|-------------------------------|
|                           |

Indicateby check mark whether the registrant is a shell company (as defined in Rule12b-2 of the Exchange Act)  **Yes   ****o   No   **x

Indicate the number of shares outstanding of each of the issuer’sclasses of common stock, as of the latest practicable date.

| Class                       |   | Outstanding at  May 9, 2007 |
|-----------------------------|--------|-----------------------------|
| Common Stock, no  par value |   | 30,311,040                  |

** **

 

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**PLC SYSTEMS INC.**

**Index**
| Part I.  | Financial  Information: |                                                                                        |
|----------|-------------------------|---------------------------------------------------------------------------------------------|
|     |                    |                                                                                        |   |
|     | Item 1.                 | Financial  Statements                                                                       |   |
|     |                    |                                                                                        |   |
|     |                    | Condensed  Consolidated Balance Sheets (unaudited)                                          |   |
|     |                    |                                                                                        |   |
|     |                    | Condensed  Consolidated Statements of Operations (unaudited)                                |   |
|     |                    |                                                                                        |   |
|     |                    | Condensed  Consolidated Statements of Cash Flows (unaudited)                                |   |
|     |                    |                                                                                        |   |
|     |                    | Notes to  Condensed Consolidated Financial Statements (unaudited)                           |   |
|     |                    |                                                                                        |   |
|     | Item 2.                 | Management’s  Discussion and Analysis of  FinancialCondition and Results of Operations |   |
|     |                    |                                                                                        |   |
|     | Item 3.                 | Quantitative  and Qualitative Disclosures about Market Risk                                 |   |
|     |                    |                                                                                        |   |
|     | Item 4.                 | Controls and  Procedures                                                                    |   |
|     |                    |                                                                                        |   |
| Part II. | Other Information:      |                                                                                        |
|     |                    |                                                                                        |   |
|     | Item  1A.               | Risk  Factors                                                                               |   |
|     |                    |                                                                                        |   |
|     | Item  6.                | Exhibits                                                                                    |   |
|          |                         |                                                                                             |  |  |

 

2

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**Part I.         FinancialInformation**

**Item 1.        Financial Statements**

**PLCSYSTEMS INC.**

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands)

(Unaudited)
| ** **                                                                                                                                 | ** ** | **March 31,  2007** | ** ** | **December 31,  2006** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| **ASSETS**                                                                                                                                 | ** ** | ** **               | ** ** | ** **                  | ** ** |
| Current assets:                                                                                                                            |       |                     |       |                        |       |
| Cash and cash  equivalents                                                                                                                 |       | $                        | 10,077     |                        | $          | 6,034 |   |
| Short-term  investments                                                                                                                    |       |    —      |       | 4,000                       |       |
| Accounts  receivable, net of allowance of $21 and $51 at March 31, 2007 and December  31, 2006, respectively                               |       | 488                      |       | 918                         |       |
| Inventories, net                                                                                                                           |       | 1,077                    |       | 1,255                       |       |
| Prepaid expenses  and other current assets                                                                                                 |       | 506                      |       | 595                         |       |
| Total current  assets                                                                                                                      |       | 12,148                   |       | 12,802                      |       |
| Equipment, furniture  and leasehold improvements, net                                                                                      |       | 151                      |       | 166                         |       |
| Other assets                                                                                                                               |       | 205                      |       | 208                         |       |
| Total assets                                                                                                                               |       | $                        | 12,504     |                        | $          | 13,176 |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                             | ** ** | ** **               | ** ** | ** **                  | ** ** |
| Current liabilities:                                                                                                                       |       |                     |       |                        |       |
| Accounts payable                                                                                                                           |       | $                        | 476        |                        | $          | 456 |   |
| Accrued  compensation                                                                                                                      |       | 626                      |       | 396                         |       |
| Accrued other                                                                                                                              |       | 247                      |       | 317                         |       |
| Deferred revenue                                                                                                                           |       | 1,811                    |       | 1,784                       |       |
| Total current  liabilities                                                                                                                 |       | 3,160                    |       | 2,953                       |       |
| Deferred revenue                                                                                                                           |       | 2,866                    |       | 3,094                       |       |
| Commitments and  contingencies                                                                                                             |       |                     |       |                        |       |
| Stockholders’ equity:                                                                                                                 |       |                     |       |                        |       |
| Preferred stock, no par  value, unlimited shares authorized, none issued and outstanding                                                   |       | —                   |       | —                      |       |
| Common stock, no par  value, unlimited shares authorized, 30,311 shares issued and outstanding as  of March 31, 2007 and December 31, 2006 |       | 93,882                   |       | 93,882                      |       |
| Additional paid in  capital                                                                                                                |       | 134                      |       | 101                         |       |
| Accumulated deficit                                                                                                                        |       | (87,217                  | )          | (86,531                     | )          |
| Accumulated other  comprehensive loss                                                                                                      |       | (321                     | )          | (323                        | )          |
| Total  stockholders’ equity                                                                                                           |       | 6,478                    |       | 7,129                       |       |
| Total liabilities and  stockholders’ equity                                                                                           |       | $                        | 12,504     |                        | $          | 13,176 |   |

 

The accompanying notesare an integral part of the condensed consolidated financial statements.

 

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**PLC SYSTEMS INC.**

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands,except per share data)

(Unaudited)
| ** **                                 | ** ** | **Three Months Ended  March 31,** | ** ** |
|--------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                 | ** ** | **2007**                                         | ** ** | **2006** | ** ** |
| Revenues:                                  |       |                                             |       |   |   |
| Product sales                              |       | $                                                | 1,134      |   | $ | 1,480 |   |
| Service fees                               |       | 359                                              |       | 409 |   |
| Total revenues                             |       | 1,493                                            |       | 1,889 |   |
| Cost of  revenues:                         |       |                                             |       |   |   |
| Product sales                              |       | 586                                              |       | 511 |   |
| Service fees                               |       | 208                                              |       | 180 |   |
| Total cost of revenues                     |       | 794                                              |       | 691 |   |
| Gross profit                               |       | 699                                              |       | 1,198 |   |
| Operating  expenses:                       |       |                                             |       |   |   |
| Selling, general and administrative        |       | 1,013                                            |       | 880 |   |
| Research and development                   |       | 491                                              |       | 533 |   |
| Total operating expenses                   |       | 1,504                                            |       | 1,413 |   |
| Gain on the sale  of manufacturing rights  |       | —                                           |       | 1,432 |   |
| Income (loss)  from operations             |       | (805                                             | )          | 1,217 |   |
| Other income,  net                         |       | 119                                              |       | 74 |   |
| Net income  (loss)                         |       | $                                                | (686       | ) | $ | 1,291 |   |
| Basic and  diluted income (loss) per share |       | $                                                | (0.02      | ) | $ | 0.04 |   |
| Average shares  outstanding:               |       |                                             |       |   |   |
| Basic                                      |       | 30,311                                           |       | 30,080 |   |
| Diluted                                    |       | 30,311                                           |       | 30,592 |   |

 

The accompanying notes are an integral part of the condensedconsolidated financial statements.

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**PLC SYSTEMS INC.**

CONDENSED CONSOLIDATEDSTATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)
| ** **                                                                                | ** ** | **Three Months Ended  March 31,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                                | ** ** | **2007**                                         | ** ** | **2006** | ** ** |
| Operating  activities:                                                                    |       |                                             |       |   |   |
| Net income (loss)                                                                         |       | $                                                | (686       | ) | $ | 1,291 |   |
|                                                                                      |       |                                             |       |   |   |
| Adjustments to reconcile net income (loss) to net  cash provided by operating activities: |       |                                             |       |   |   |
| Depreciation and  amortization                                                            |       | 21                                               |       | 40 |   |
| Loss on retirement of equipment                                                           |       | —                                           |       | 69 |   |
| Compensation expense from stock options                                                   |       | 33                                               |       | 10 |   |
| Change in assets and liabilities:                                                         |       |                                             |       |   |   |
| Accounts receivable                                                                       |       | 430                                              |       | (191 | ) |
| Inventory                                                                                 |       | 178                                              |       | (33 | ) |
| Prepaid expenses and other assets                                                         |       | 89                                               |       | 125 |   |
| Accounts payable                                                                          |       | 20                                               |       | 87 |   |
| Deferred revenue                                                                          |       | (202                                             | )          | (74 | ) |
| Accrued liabilities                                                                       |       | 160                                              |       | (246 | ) |
| Net cash  provided by operating activities                                                |       | 43                                               |       | 1,078 |   |
|                                                                                      |       |                                             |       |   |   |
| Investing  activities:                                                                    |       |                                             |       |   |   |
| Purchase of investments                                                                   |       | —                                           |       | (4,000 | ) |
| Maturity of investments                                                                   |       | 4,000                                            |       | 5,400 |   |
| Purchase of equipment                                                                     |       | (3                                               | )          | (12 | ) |
| Net cash  provided by investing activities                                                |       | 3,997                                            |       | 1,388 |   |
|                                                                                      |       |                                             |       |   |   |
| Financing  activities:                                                                    |       |                                             |       |   |   |
| Net proceeds from exercise of stock options                                               |       | —                                           |       | 3 |   |
| Net cash provided  by financing activities                                                |       | —                                           |       | 3 |   |
|                                                                                      |       |                                             |       |   |   |
| Effect of  exchange rate changes on cash and cash equivalents                             |       | 3                                                |       | 4 |   |
| Net increase in  cash and cash equivalents                                                |       | 4,043                                            |       | 2,473 |   |
| Cash and cash  equivalents at beginning of period                                         |       | 6,034                                            |       | 2,560 |   |
| Cash and cash equivalents  at end of period                                               |       | $                                                | 10,077     |   | $ | 5,033 |   |

 

The accompanying notes are an integral part of the condensedconsolidated financial statements.

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**PLCSYSTEMS INC.**

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2007

***1.             Nature of Business***

PLC Systems Inc. (“PLC” or the “Company”) is a medical device companyspecializing in innovative technologies for the cardiac and vascularmarkets.  The Company pioneered andmanufactures the *CO**2** HeartLaser System* (the “Heart Laser System”) that cardiacsurgeons use to perform carbon dioxide (CO2)transmyocardial revascularization, or TMR, to alleviate symptoms of severeangina.  In addition, the Company hascommenced clinical trials for the Company’s RenalGuard Therapy and RenalGuardSystem (collectively “RenalGuard”). RenalGuard Therapy is designed to reducethe toxic effects that contrast media can have on the kidneys.  Thistherapy is based on the theory that creating and maintaining a high urineoutput is beneficial to patients undergoing imaging procedures where contrastagents are used.  The real-timemeasurement and matched fluid replacement design of the Company’s RenalGuardSystem is intended to ensure that a high urine flow is maintained before,during and after these procedures, thus allowing the body to rapidly eliminatecontrast, reducing its toxic effects. The RenalGuard System, with its matchedfluid replacement capability, is intended to minimize the risk of over- orunder-hydration.

InDecember 2006, the Company received full FDA approval to conduct its firsthuman clinical trial utilizing RenalGuard under an investigational deviceexemption. This 40-patient pilot clinical trial is designed to evaluate thesafety of the RenalGuard System and its ability to accurately measure andbalance fluid inputs and outputs on patients undergoing a catheterizationimaging procedure where contrast media will be administered.

TheCompany hopes to be able to demonstrate through future clinical trials thatRenalGuard is also safe and effective in preventing contrast-inducednephropathy (“CIN”), a form of acute renal failure caused by exposure tocontrast media for patients undergoing imaging procedures.

On March 20, 2007, the Company entered into adistribution agreement with Novadaq Corp. (“Novadaq”), a subsidiary of NovadaqTechnologies Inc., pursuant to which the Company appointed Novadaq as itsexclusive distributor in the United States for the TMR business.  This agreement amended and restated theexclusive distribution agreement between the Company and Edwards LifesciencesLLC (“Edwards”), which had been assigned by Edwards to Novadaq on the samedate.  The agreement with Novadaqreflects substantially the same roles, responsibilities and financial terms asthe Company’s previous agreement with Edwards.

***2.            ******Basis of Presentation***

The accompanying unauditedcondensed consolidated financial statements of the Company have been preparedin accordance with generally accepted accounting principles for interimfinancial information and with the instructions to Form 10-Q and Article 10 ofRegulation S-X.  Accordingly, they do notinclude all of the information and footnotes required by generally acceptedaccounting principles for complete financial statements.  In the opinion of management, all adjustments(consisting of normal recurring adjustments) considered necessary for a fairpresentation have been included. Operating results for the three months ended March 31, 2007 are

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not necessarily indicative of the results that may be expected for theyear ending December 31, 2007.  Thesefinancial statements should be read in conjunction with the consolidatedfinancial statements and footnotes thereto included in the Company’s AnnualReport on Form 10-K for the year ended December 31, 2006.

***3.             NewAccounting Pronouncement***

In June 2006, the Financial Accounting StandardsBoard (“FASB”) issued Interpretation No. 48, “Accounting for Uncertainty inIncome Taxes, an interpretation of FASB Statement 109” (“FIN 48”).  This statement clarifies the criteria that anindividual tax position must satisfy for some or all of the benefits of thatposition to be recognized in a company’s financial statements.  FIN 48 prescribes a recognition threshold ofmore-likely-than-not, and a measurement attribute for all tax positions takenor expected to be taken on a tax return, in order for those tax positions to berecognized in the financial statements.

Effective January 1, 2007, the Company has adoptedthe provisions of FIN 48. The adoption of FIN 48 did not have an impact on theCompany’s consolidated financial statements. Effective with the adoption of FIN48, the Company recognizes interest and penalties related to uncertaintax positions as a component of the provision for income taxes.

As of January 1, 2007, the Company had deferred taxassets of $51 million, primarily comprised of federal and state tax netoperating loss carryforwards and federal and state research and developmentcredit carryforwards. Under the Internal Revenue Code, certain substantialchanges in the Company’s ownership may limit the amount of net operating losscarryforwards that can be utilized in any one year to offset future taxableincome. Any carryforwards that will expire prior to utilization as the resultof any limitations will be removed from deferred tax assets with a correspondingreduction of the valuation allowance. Due to the existence of thevaluation allowance, future changes in the Company’s unrecognized taxbenefits will not impact its effective tax rate.

The Company maintained a reserve of $70,000 as ofMarch 31, 2007 for any potential tax matters that could arise in thefuture.  The reserve did not change duringthe three months ended March 31, 2007, nor does the Company expect that theamount of unrecognized tax benefits will change significantly within the next12 months.

The Company files income tax returns in the U.S.federal jurisdiction and in several state and foreign jurisdictions. For U.S.federal and state tax purposes, the tax years 2003 through 2006 remain open toexamination.  In addition, the amount ofthe Company’s federal and state net operating loss carryforwards may be subjectto examination and adjustment.  Theexamination period for the Company’s foreign jurisdictions range from 1997through 2006.

***4.             Inventories***

Inventories are stated at the lower of cost (computed on afirst-in, first-out method) or market value and include allocations of laborand overhead.  As of March 31, 2007 andDecember 31, 2006, inventories consisted of the following (in thousands):

7

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|                  | ** ** | **March 31,  2007** | ** ** | **December 31,  2006** | ** ** |
|------------------|------------|--------------------------|------------|-----------------------------|------------|
| Raw materials    |       | $                        | 722        |                        | $          | 791 |   |
| Work in progress |       | 124                      |       | 118                         |       |
| Finished goods   |       | 231                      |       | 346                         |       |
|             |       | $                        | 1,077      |                        | $          | 1,255 |   |

 

At March 31, 2007 and December 31, 2006, inventories arestated net of a specific obsolescence allowance of $646,000 and $548,000,respectively.

***5.             Stock-Based Compensation***

*StockOption and Stock Purchase Plans*

In May 2005,the Company adopted the 2005 Stock Incentive Plan (the “2005 Plan”).  The 2005 Plan has replaced the 1997 ExecutiveStock Option Plan, 2000 Equity Incentive Plan, 2000 Non-Statutory Stock OptionPlan and 2000 Non-Qualified Performance and Retention Equity Plan(collectively, the “Previous Plans”), under which no further awards can begranted.

The number of stock options that may be grantedunder the 2005 Plan is equal to 2,156,175 shares of common stock (subject toadjustment in the event of stock splits and other similar events), plus suchnumber of shares as may become available under the Previous Plans after thedate of the adoption of the 2005 Plan because any award previously grantedunder any such plan expires or is terminated, surrendered or cancelled withouthaving been fully exercised or is forfeited in whole or in part or results inany common stock not being issued, provided that such number of additionalshares may not exceed 2,535,492. Incentive stock options are issuable only to employees of the Company,while non-qualified options may be issued to non-employee directors,consultants, and others, as well as to employees. The options granted under thePrevious Plans and the 2005 Plan become exercisable either immediately, orratably over one to four years from the date of grant, and expire ten yearsfrom the date of grant.

The Company grants stock options to its non-employeedirectors. Generally, new non-employee directors receive an initial grant of anoption to purchase 30,000 shares of the Company’s common stock that vests ininstallments over three years.  Once theinitial grant has fully vested, non-employee directors other than the Chairmanof the Board receive an annual grant of an option to purchase 15,000 shares ofthe Company’s common stock that generally vests in four equal quarterlyinstallments. The Chairman of the Board receives an annual grant of an optionto purchase 30,000 shares of the Company’s common stock that generally vests infour equal quarterly installments in the same manner as the options grantedannually to the other non-employee directors. All such options have an exerciseprice equal to the fair market value of the common stock on the date of grant.

The per share exercise price of an incentive stockoption may not be less than the fair market value of the common stock on thedate the option is granted. The Company must grant non-qualified options at anexercise price of at least 85% of the fair market value of the common stock.

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Options granted during the three months ended March31, 2007 will vest ratably annually over a three year period foremployees.  Options granted during 2006will vest ratably annually over a three year period for employees and ratablyquarterly over a one year period for non-employee directors.

The following is a summary of option activity under all plans (inthousands, except per option data):
|                                 | ** ** | **Number  of Options** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Average  Remaining  Contractual  Life (Years)** | ** ** |
|---------------------------------|------------|------------------------|------------|----------------------------------------|------------|--------------------------------------------------------|------------|
|                            |       |                   |       |                                   |       |                                                   |       |
| Outstanding,  December 31, 2006 |       | 4,767                  |       | $                                      | 1.05       |                                                   |       |   |
| Granted                         |       | 50                     |       | 0.61                                   |       |                                                   |       |
| Exercised                       |       | —                 |       | —                                 |       |                                                   |       |
| Forfeited                       |       | —                 |       | —                                 |       |                                                   |       |
| Expired                         |       | —                 |       | —                                 |       |                                                   |       |
| Outstanding,  March 31, 2007    |       | 4,817                  |       | 1.05                                   |       | 5.99                                                   |       |
| Exercisable, March 31,  2007    |       | 4,265                  |       | 1.09                                   |       | 5.57                                                   |       |
|                                 |            |                        |            |                                        |            |                                                        |            |  |

 

The following table summarizes unvested option activity during thethree months ended March 31, 2007:
|                              | ** ** | **Number  of  Options**                                                   | ** ** | **Weighted  Average  Grant Date  Fair Value** | ** ** |
|------------------------------|------------|---------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                   | ** ** | **(in thousands, except weighted average data)** | ** ** |
| ** **                   | ** ** | ** **                                                                | ** ** |
| Unvested,  December 31, 2006 |       | 531                                                                       |       | $                                                       | 0.51       |   |
| Granted                      |       | 50                                                                        |       | 0.43                                                    |       |
| Vested                       |       | (29                                                                       | )          | 0.48                                                    |       |
| Forfeited                    |       | —                                                                    |       | —                                                  |       |
| Unvested, March 31,  2007    |       | 552                                                                       |       | 0.51                                                    |       |
|                              |            |                                                                           |            |                                                         |            |  |

 

*SFAS No. 123R*

Effective January 1, 2006, the Company adopted the fair valuerecognition provisions of Statement of Financial Accounting Standards No. 123(revised 2004), “Share-based Payment” (“SFAS No. 123R”), using themodified-prospective transition method, which did not require restatement ofprior period results. In the three months ended March 31, 2007, the Companyrecorded compensation expense of $33,000 for all share-based payments grantedsubsequent to December 31, 2005, based on the grant-date fair value estimatedin accordance with the provisions of SFAS No. 123R. The Company estimates anexpected forfeiture rate based on its historical forfeiture activity.  Actual results, and future changes inestimates, may differ substantially from the Company’s current estimates.  As of March 31, 2007, the Company had $205,000of total unrecognized compensation cost related to its unvested options, whichis expected to be recognized over a weighted average period of 2.0 years.

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The weighted average fair value of options issuedduring the three months ended March 31, 2007 was estimated using theBlack-Scholes model.

|                          | ** ** | **Three Months Ended  March 31, 2007** | ** ** |
|--------------------------|------------|------------------------------------------------------------|------------|
| Expected life  (years)   |       | 6.00                                                       |       |
| Interest rate            |       | 4.68                                                       | %          |
| Volatility               |       | 77.4                                                       | %          |
| Expected  dividend yield |       | None                                                       |       |
| Value of option granted  |       | $                                                          | 0.43       |   |
|                          |            |                                                            |            |  |

 

The expected lifeis calculated using the simplified method. The risk-free interest rate is basedon the U.S. Treasury yield curve in effect at the time of the grant for theexpected term period.  Expectedvolatility is based exclusively on historical volatility data of the Company’scommon stock.

The Company has a 2000 Employee Stock Purchase Plan(the “Purchase Plan”) for all eligible employees whereby shares of the Company’scommon stock may be purchased at six-month intervals at 95% of the closingprice of the Company’s common stock on the last business day of the relevantplan period.  Employees may purchaseshares having a value not exceeding 10% of their gross compensation during anoffering period, subject to certain additional limitations. Under the Purchase Plan,employees of the Company purchased 1,235 shares of common stock in 2006 at anaverage price of $0.65 per share.  There wasno purchase activity in the three months ended March 31, 2007.  At March 31, 2007, 321,252 shares werereserved for future issuance under the Purchase Plan.

***6.             Revenue Recognition***

The Company records revenue from the sale of TMRkits at the time of shipment to Novadaq. TMR kit revenues include the amount invoiced to Novadaq for kits shippedpursuant to purchase orders received, as well as an amortized portion ofdeferred revenue related to a payment of $4,533,333 received in February2004.  This payment was made in exchangefor a reduction in the prospective purchase price the Company receives upon asale of the kits.  The Company isamortizing this payment into its Consolidated Statements of Operations asrevenue over a seven year period (culminating in 2010) under theunits-of-revenue method as prescribed by Emerging Issues Task Force 88-18, “Salesof Future Revenue”.  The Companydetermined that a seven year timeframe was the most appropriate amortizationperiod based on a valuation model it used to assess the economic fairness ofthe payment. Factors the Company considered in developing this valuation modelincluded the estimated foregone revenues over a seven year period resultingfrom the reduction in the prospective purchase price payable to the Company, adiscount rate deemed appropriate to this transaction and an estimate of theremaining economic useful life of the current TMR kit design, without anybenefit being given to potential future product improvements the Company maymake.  The Company reviews annually, andadjusts if necessary, the prospective revenue amortization rate for kits basedon its best estimate of the total number of kits likely remaining to be shippedto hospital customers by Novadaq through 2010. The Company recordedamortization of $190,000 and $155,000 in the three months ended March 31, 2007and 2006, respectively, which is included in revenues in the ConsolidatedStatements of Operations.

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TMR lasers are billed to Novadaq in accordance withpurchase orders that the Company receives. Invoiced TMR lasers are recorded as other current assets and deferredrevenue on the Company’s Consolidated Balance Sheet until such time as thelaser is shipped to a hospital, at which time the Company records revenue andcost of revenue.

Under the terms of the TMR distribution agreement,once Novadaq has recovered a prescribed amount of revenue from a hospital forthe use or purchase of a TMR laser, any additional revenues earned by Novadaqare shared with the Company pursuant to a formula established in thedistribution agreement. The Company only records its share of such additionalrevenue, if any, at the time the revenue is earned.

The Company records revenuefrom the sale of TMR kits and TMR lasers to international distributors orhospitals at the time of shipment.

Revenues from service and maintenance contracts are recognized ratablyover the life of the contract.

Installation revenues related to a TMR laser transaction are recordedas a component of service fees when the laser is installed.

***7.             Earnings(Loss) per Share***

In the three months ended March 31, 2007, basic anddiluted loss per share have been computed using only the weighted averagenumber of common shares outstanding during the period without giving effect toany potential future issuances of common stock related to stock optionprograms, since their inclusion would be antidilutive.

In thethree months ended March 31, 2006, basic earnings per share have been computedusing only the weighted average number of common shares outstanding during theperiod, while diluted earnings per share was computed using the weightedaverage number of common shares outstanding during the period plus the effectof outstanding stock options using the treasury stock method.  In calculating diluted earnings per share, the dilutive effect of stockoptions is computed using the average market price for the respective period.

For the three months endedMarch 31, 2007 and 2006, 4,817,000 and 2,102,000 shares, respectively,attributable to outstanding stock options and warrants were excluded from thecalculation of diluted earnings per share because the effect would have been antidilutive.  The following table sets forth thecomputation of basic and diluted earnings (loss) per share:

 

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| ** **                                                                                            | ** ** | **Three Months Ended March 31,**               | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                                                                            | ** ** | **2007**                                                           | ** ** | **2006** | ** ** |
| ** **                                                                                            | ** ** | **(In thousands, except per share data)** | ** ** |
|                                                                                                  |       |                                                               |       |   |   |
| Basic:                                                                                                |       |                                                               |       |   |   |
| Net income (loss)                                                                                     |       | $                                                                  | (686       | ) | $ | 1,291 |   |
| Weighted average shares outstanding                                                                   |       | 30,311                                                             |       | 30,080 |   |
| Basic earnings (loss) per share                                                                       |       | $                                                                  | (0.02      | ) | $ | 0.04 |   |
|                                                                                                  |       |                                                               |       |   |   |
| Diluted:                                                                                              |       |                                                               |       |   |   |
| Net income (loss)                                                                                     |       | $                                                                  | (686       | ) | $ | 1,291 |   |
| Weighted average shares outstanding                                                                   |       | 30,311                                                             |       | 30,080 |   |
| Assumed impact of the exercise of outstanding  dilutive stock options using the treasury stock method |       | —                                                             |       | 512 |   |
| Weighted average common and common equivalent shares                                                  |       | 30,311                                                             |       | 30,592 |   |
| Diluted earnings  (loss) per share                                                                    |       | $                                                                  | (0.02      | ) | $ | 0.04 |   |

 

***8.             ComprehensiveIncome (Loss)***

Totalcomprehensive loss for the three month period ended March 31, 2007 amounted to$684,000 as compared to comprehensive income of $1,294,000 for the three monthperiod ended March 31, 2006. Comprehensive income (loss) is comprised of net income (loss) plus theincrease/decrease in currency translation adjustment.

# ***9.             Warranty andPreventative Maintenance Costs***

The Company warranties its products againstmanufacturing defects under normal use and service during the warrantyperiod.  The Company obtains similarwarranties from a majority of its suppliers, including those who supplycritical Heart Laser System components. In addition, under the terms of its TMR distribution agreement withNovadaq, the Company is able to bill Novadaq for actual warranty costs,including preventative maintenance services, up to a specified amount duringthe warranty period.

The Company evaluates the estimated futureunrecoverable costs of warranty and preventative maintenance services for itsinstalled base of lasers on a quarterly basis and adjusts its warranty reserveaccordingly.  The Company considers allavailable evidence, including historical experience and information obtainedfrom supplier audits.

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Changesin the warranty accrual were as follows (in thousands):
|                                                            | ** ** | **Three Months Ended  March 31,** | ** ** |
|------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                 | ** ** | **2007**                                         | ** ** | **2006** | ** ** |
| Balance,  beginning of period                              |       | $                                                | 60         |   | $ | 60 |   |
| Payments made                                              |       | —                                           |       | — |   |
| Change in  liability for warranties issued during the year |       | —                                           |       | 5 |   |
| Change in  liability for preexisting warranties            |       | —                                           |       | (5 | ) |
| Balance, end of period                                     |       | $                                                | 60         |   | $ | 60 |   |

 

***10.******                                          ******Gain on Sale of Manufacturing Rights***

In February 2004, theCompany signed an agreement with Edwards to assume development andmanufacturing of the Optiwave 980 Cardiac Laser Ablation System (“Optiwave 980”)and related system disposables. In March 2006, the Company and Edwardsterminated this agreement. The Company received $1,500,000 in consideration forselling its Optiwave 980 system related disposable manufacturing rights toEdwards.  In conjunction with the sale,the Company wrote off certain inventory and capital assets acquired tomanufacture the Optiwave 980 disposables and recorded a net gain of $1,432,000in its Consolidated Statement of Operations during the three months ended March31, 2006.

**Item 2.****                       Management’sDiscussion and Analysis of Financial Condition and Results of Operations**

Thisquarterly report (including certain information incorporated herein byreference) contains forward-looking statements within the meaning of Section27A of the Securities Act of 1933, as amended, and Section 21E of theSecurities Exchange Act of 1934, as amended (the “Exchange Act”). Statementscontaining terms such as “believes”, “plans”, “expects”, “anticipates”, “intends”,“estimates” and similar expressions reflect uncertainty and are forward-lookingstatements. Forward-looking statements are based on current plans andexpectations and involve known and unknown important risks and uncertaintiesthat could cause actual results to differ materially from those described inthe forward-looking statements. Such important factors and uncertaintiesinclude, but are not limited to, those set forth below in Part II, Item 1A.Risk Factors, and elsewhere in this quarterly report.

# **Overview**

We are a medical device company specializing in innovative technologiesfor the cardiac and vascular markets.  Wepioneered and manufacture the Heart Laser System that cardiac surgeons use toperform TMR to alleviate symptoms of severe angina.  In addition, we recently began clinicaltrials for our RenalGuard Therapy and RenalGuard System. RenalGuard Therapy isdesigned to reduce the toxic effects that contrast media can have on thekidneys.  This therapy is based on the theory that creating andmaintaining a high urine output is beneficial to patients undergoing imagingprocedures where contrast agents are used. The real-time measurement and matched fluid replacement design of ourRenalGuard System is intended to ensure that a high urine flow is maintainedbefore, during and after these procedures, thus allowing the body to 

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rapidly eliminate contrast, reducing its toxic effects. The RenalGuardSystem, with its matched fluid replacement capability, is intended to minimizethe risk of over- or under-hydration.

InDecember 2006, we received full FDA approval to conduct our first humanclinical trial utilizing RenalGuard under an investigational device exemption.This 40-patient pilot clinical trial is designed to evaluate the safety of theRenalGuard System and its ability to accurately measure and balance fluidinputs and outputs on patients undergoing a catheterization imaging procedurewhere contrast media will be administered.

We hope to be able todemonstrate through future clinical trials that RenalGuard is also safe andeffective in preventing contrast-induced nephropathy, a form of acute renalfailure caused by exposure to contrast media for patients undergoing imagingprocedures.

Our U.S. distributor (Novadaq currently and Edwards prior to March 20,2007) is our largest customer, accounting for 82% and 88% of our total revenuesin the three months ended March 31, 2007 and the year ended December 31, 2006,respectively. We expect a similar level of sales concentration to continue inthe near future with Novadaq as our largest customer now that they hold theexclusive U.S. distribution rights for our TMR products.

Approximately 78% and 95% of our revenues in thethree months ended March 31, 2007 and the year ended December 31, 2006,respectively, came from the sale and service of TMR lasers and relateddisposable kits.

Although not a direct measure, we believe a leadingindicator of the adoption rate of TMR as a treatment for severe angina is TMRkit shipments to U.S. hospitals. Aggregate TMR kit shipments to U.S. hospitalsthrough Novadaq and Edwards decreased approximately 8% in the three monthsended March 31, 2007 as compared to the three months ended March 31, 2006. Webelieve this decline in first quarter TMR kit shipments was primarily theresult of the transition in distribution responsibilities from Edwards toNovadaq just ten days prior to the end of the first fiscal quarter.

We believe it is likely to take at least through thethird quarter of 2007 for Novadaq’s sales force to become fully integrated,trained and proficient in terms of selling our TMR products.  As such, we believe that our second and thirdquarter revenues and results of operations in 2007 could be lower than our sameresults in the corresponding periods in 2006. The success of the transition of distribution responsibilities fromEdwards to Novadaq will in large part impact our revenue and operating resultsduring future quarters in 2007 and 2008 and we will be largely dependent on thesuccess of Novadaq’s sales and marketing efforts in the future to increase ourinstalled base of TMR lasers and increase TMR procedure volumes and revenues.

Our management reviews a number of key performanceindicators to assist them in determining how to allocate resources and run ourday to day operations. These indicators include (1) actual prior quarterlysales trends, (2) projected TMR laser and kit sales for the next four quarters,as provided by our exclusive U.S. distributor in a rolling twelve month salesforecast, (3) research and development progress as measured against internalproject plan objectives, (4) budget to actual financial expenditure results,(5) inventory levels (both our own and distributors’) and (6) short term andlong term projected cash flows of the business.

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# **CriticalAccounting Policies and Estimates**

Our financial statements are based on the application of significantaccounting policies, many of which require us to make significant estimates andassumptions (see Note 2 to the Consolidated Financial Statements included inour Annual Report on Form 10-K for the year ended December 31, 2006).  We believe that the following are some of themore material judgment areas in the application of our accounting policies thatcurrently affect our financial condition and results of operations.

# ***Inventories***

Inventories are stated at the lower of cost(computed on a first-in, first-out method) or market value and includeallocations of labor and overhead.  Aspecific obsolescence allowance is provided for slow moving, excess andobsolete inventory based on our best estimate of the net realizable value ofinventory on hand taking into consideration factors such as (1) actual trailingtwelve month sales, (2) expected future product line demand, based in part onsales forecast input received from our exclusive U.S. distributor, and (3)service part stocking levels which, in management’s best judgment, areadvisable to maintain in order to meet warranty, service contract and time andmaterial spare part demands. Historically, we have found our reserves to be adequate.

# ***Accounts Receivable***

Accounts receivable is stated at the amount weexpect to collect from the outstanding balance. We continuously monitor collections from customers, and we maintain aprovision for estimated credit losses based upon historical experience and anyspecific customer collection issues that we have identified.  Historically, we have not experiencedsignificant losses related to our accounts receivable, primarily from Edwards.Collateral is not generally required. If the financial condition of ourcustomers were to deteriorate, resulting in an impairment of their ability tomake payments, additional allowances may be required.

***Research and Development Expenses***

Research and development expenses are expensed asincurred.

# ***Warranty and PreventativeMaintenance Costs***

We warranty our products against manufacturingdefects under normal use and service during the warranty period.  We obtain similar warranties from a majorityof our suppliers, including those who supply critical Heart Laser Systemcomponents.  In addition, under the termsof our TMR distribution agreement with Novadaq, we are able to bill Novadaq foractual warranty costs, including preventative maintenance services, up to aspecified amount during the warranty period.

We evaluate the estimated future unrecoverable costsof warranty and preventative maintenance services for our installed base oflasers on a quarterly basis and adjust our warranty reserve accordingly.  We consider all available evidence, includinghistorical experience and information obtained from supplier audits.

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## ***Revenue Recognition***

We record revenue from the sale of TMR kits at thetime of shipment to Novadaq.  TMR kitrevenues include the amount invoiced to Novadaq for kits shipped pursuant topurchase orders received, as well as an amortized portion of deferred revenuerelated to a payment of $4,533,333 received in February 2004.  This payment was made in exchange for areduction in the prospective purchase price we receive upon a sale of the kits.  We are amortizing this payment into ourConsolidated Statements of Operations as revenue over a seven year period(culminating in 2010) under the units-of-revenue method as prescribed byEmerging Issues Task Force 88-18, “Sales of Future Revenue”.  We determined that a seven year timeframe wasthe most appropriate amortization period based on a valuation model it used toassess the economic fairness of the payment. Factors we considered indeveloping this valuation model included the estimated foregone revenues over aseven year period resulting from the reduction in the prospective purchaseprice payable to us, a discount rate deemed appropriate to this transaction andan estimate of the remaining economic useful life of the current TMR kitdesign, without any benefit being given to potential future productimprovements we may make.  We reviewannually, and adjust if necessary, the prospective revenue amortization ratefor kits based on our best estimate of the total number of kits likelyremaining to be shipped to hospital customers by Novadaq through 2010. Werecorded amortization of $190,000 and $155,000 in the three months ended March31, 2007 and 2006, respectively, which is included in revenues in ourConsolidated Statements of Operations.

TMR lasers are billed to Novadaq in accordance withpurchase orders that we receive. Invoiced TMR lasers are recorded as other current assets and deferredrevenue on our Consolidated Balance Sheet until such time as the laser isshipped to a hospital, at which time we record revenue and cost of revenue.

Under the terms of the TMR distribution agreement,once Novadaq has recovered a prescribed amount of revenue from a hospital forthe use or purchase of a TMR laser, any additional revenues earned by Novadaqare shared with us pursuant to a formula established in the distributionagreement. We only record our share of such additional revenue, if any, at thetime the revenue is earned.

We record revenue from thesale of TMR kits and TMR lasers to international distributors or hospitals atthe time of shipment.

Revenues from service and maintenance contracts are recognized ratablyover the life of the contract.

Installation revenues related to a TMR laser transaction are recordedas a component of service fees when the laser is installed.

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## **Results of Operations**

Resultsfor the three months ended March 31, 2007 and 2006 and the related percent ofrevenues were as follows:
| ** **                             | ** ** | **Three Months Ended   March 31,** | ** ** |
|----------------------------------------|------------|--------------------------------------------------------|------------|
| ** **                             | ** ** | **2007**                                               | ** ** | **2006** | ** ** |
| ** **                             | ** ** | **$**                                                  | ** ** | **%** | ** ** | **$** | ** ** | **%** | ** ** |
| ** **                             | ** ** | **(dollars in thousands)**                   | ** ** |
| Total revenues                         |       | $                                                      | 1,493      |   | 100 | % | $ | 1,889 |   | 100 | % |
| Total cost of revenues                 |       | 794                                                    |       | 53 |   | 691 |   | 37 |   |
| Gross profit                           |       | 699                                                    |       | 47 |   | 1,198 |   | 63 |   |
| Selling, general &  administrative |       | 1,013                                                  |       | 68 |   | 880 |   | 47 |   |
| Research &  development expenses   |       | 491                                                    |       | 33 |   | 533 |   | 28 |   |
| Total operating  expenses              |       | 1,504                                                  |       | 101 |   | 1,413 |   | 75 |   |
| Gain on sale of  manufacturing rights  |       | —                                                 |       | — |   | 1,432 |   | 76 |   |
| Income (loss) from  operations         |       | (805                                                   | )          | (54 | ) | 1,217 |   | 64 |   |
| Other income                           |       | 119                                                    |       | 8 |   | 74 |   | 4 |   |
| Net income (loss)                      |       | $                                                      | (686       | ) | (46 | )% | $ | 1,291 |   | 68 | % |

 
| ** **                                      | ** ** | **Three Months Ended  March 31,** | ** ** | **Increase (decrease)** | ** ** |
|-------------------------------------------------|------------|--------------------------------------------------|------------|------------------------------|------------|
| ** **                                      | ** ** | **2007**                                         | ** ** | **2006**                     | ** ** | **over 2006** | ** ** |
| ** **                                      | ** ** | **$**                                            | ** ** | **$**                        | ** ** | **$** | ** ** | **%** | ** ** |
| ** **                                      | ** ** | **(dollars in thousands)**             | ** ** |
| Product sales                                   |       | $                                                | 1,134      |                         | $          | 1,480 |   | $ | (346 | ) | (23 | )% |
| Service fees                                    |       | 359                                              |       | 409                          |       | (50 | ) | (12 | ) |
| Total revenues                                  |       | 1,493                                            |       | 1,889                        |       | (396 | ) | (21 | ) |
| Product cost of sales                           |       | 586                                              |       | 511                          |       | 75 |   | 15 |   |
| Service fees cost of  sales                     |       | 208                                              |       | 180                          |       | 28 |   | 16 |   |
| Total cost of revenues                          |       | 794                                              |       | 691                          |       | 103 |   | 15 |   |
| Gross profit                                    |       | 699                                              |       | 1,198                        |       | (499 | ) | (42 | ) |
| Selling, general &  administrative expenses |       | 1,013                                            |       | 880                          |       | 133 |   | 15 |   |
| Research &  development expenses            |       | 491                                              |       | 533                          |       | (42 | ) | (8 | ) |
| Total operating  expenses                       |       | 1,504                                            |       | 1,413                        |       | 91 |   | 6 |   |
| Gain on sale of  manufacturing rights           |       | —                                           |       | 1,432                        |       | (1,432 | ) | (100 | ) |
| Income (loss) from  operations                  |       | (805                                             | )          | 1,217                        |       | (2,022 | ) | (166 | ) |
| Other income                                    |       | 119                                              |       | 74                           |       | 45 |   | 61 |   |
| Net income (loss)                               |       | $                                                | (686       | )                            | $          | 1,291 |   | $ | (1,977 | ) | (153 | )% |

 

***Product Sales***

TMR laser revenues, the largest component of productsales in the three months ended March 31, 2007, decreased by $356,000, or 46%,as compared to the three months ended March 31, 2006.  International TMR laser revenues decreased$220,000 due to one TMR laser sale in three months ended March 31, 2006 but no lasersales in the three months ended March 31, 2007. Domestic TMR laser revenues decreased $136,000, or 25%, primarily as aresult of decreased revenue sharing earned under our TMR distributionagreements.

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Disposable TMR kit revenues, the second largestcomponent of product sales in the three months ended March 31, 2007, decreasedby $246,000, or 38%, as compared to the three months ended March 31, 2006.  Domestic disposable TMR kit revenuesdecreased $232,000 resulting from a lower volume of kit shipments to Edwards asEdwards reduced its inventory of TMR kits in anticipation of the assignment ofdistribution rights to Novadaq.  Thisdecrease in TMR kit shipments to Edwards was offset in part by a $35,000increase in deferred kit revenue amortization. International disposable TMR kit revenues decreased $14,000, or 52%, inthe three months ended March 31, 2007 as compared to the three months ended March31, 2006.

Other product sales increased $156,000, or 240%, ascompared to the three months ended March 31, 2006.  This increase was driven primarily by (1) newmanufacturing contract assembly product revenues, which we only recentlyundertook as a new source of revenue during the fourth quarter of 2006, and (2)increased sales of new and refurbished surgical laser tubes to a single OEMcustomer. We believe the addition of new contract assembly work will result inincreased revenues in this category of product sales during the remaining threefiscal quarters of 2007 as compared to what we realized in this category in thecorresponding fiscal quarters in 2006.

Optiwave 980 revenues to Edwards were $100,000 inthe three months ended March 31, 2007 while there were no sales in the threemonths ended March 31, 2006.  In December2006, Edwards announced the discontinuation of the Optiwave 980, which wemanufactured for Edwards under a supply agreement prior to its beingdiscontinued.  We do not expect to generateany significant revenues from this product line in the future.

***Service FeeRevenues***

Service fees decreased$50,000, or 12%, in the three months ended March 31, 2007 as compared to thethree months ended March 31, 2006 due to a lower number of billable servicecalls.

***Gross Profit***

Total gross profit was $699,000, or 47% of totalrevenues, in the three months ended March 31, 2007 as compared with grossprofit of $1,198,000, or 63% of total revenues, in the three months ended March31, 2006.  The decrease in gross profitdollars is due to (1) lower disposable TMR revenues, (2) a decrease inadditional revenue sharing earned under our U.S. TMR distribution agreement,(3) lower international TMR laser revenue, (4) lower service revenues and (5)higher manufacturing period expenses. These decreases were offset in part byhigher sales of new and refurbished surgical tubes and contract assemblyservices**.**

***Selling, Generaland Administrative Expenses***

Selling, general and administrative (“SG&A”)expenditures increased 15% in the three months ended March 31, 2007 as comparedto the three months ended March 31, 2006. This increase is related to increasedheadcount and higher compensation expense, as well as higher corporate andlegal expenditures incurred in connection with the transfer of the U.S. TMR 

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distribution agreement from Edwards to Novadaq.

***Research and Development Expenses***

Research and development expenditures decreased 8% in the three monthsended March 31, 2007 as compared to the three months ended March 31, 2006.  This decline was primarily due to a decreasein expenditures in connection with new product development and related programcosts related to RenalGuard.  Thisdecrease was offset largely by an increase in clinical trial expenditures forRenalGuard in the first quarter of 2007.

We expect to continue to incur significant newresearch and development expenditures for the remainder of 2007 and futureyears.  Our near term development effortsare focused on performing clinical trials of our newest product initiative,RenalGuard, which should lead to increased research and developmentexpenditures from that which we incurred in the first quarter of 2007 at leastthrough 2008.

***Gain on the Sale of ManufacturingRights***

In March 2006, we received $1,500,000 related to thesale our Optiwave 980 disposable manufacturing rights to Edwards.  In conjunction with this transaction, wewrote off certain production equipment and inventory and recorded a net gain of$1,432,000 in the three months ended March 31, 2006.

***Other Income***

The largest component of other income consists ofinterest income earned on our cash, cash equivalents and short-terminvestments.  Interest income increased$45,000 in the three months ended March 31, 2007 as compared to the threemonths ended March 31, 2006 due to higher investable cash balances as well ashigher interest rates earned on our cash, cash equivalents and short-terminvestments.

***Net Income (Loss)***

In the three months ended March 31, 2006, werecorded a gain from the sale of our Optiwave 980 disposable manufacturingrights to Edwards.  This non-recurringgain as well as higher sales, gross margin and lower operating expensesresulted in recorded net income of $1,291,000 in the three months ended March 31,2006 as compared to a net loss of $686,000 in the three months ended March 31,2007.

***Kit Shipments***

We view disposable kit shipments to end users as animportant metric in evaluating our business. We believe that kit shipments (particularly kit shipments to U.S.hospitals), although not a direct measure, are a reasonable indicator for theadoption of TMR as a therapy in the marketplace.  Disposable kit shipments to end users are asfollows:

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|                                 | ** ** | **Three Months Ended  March 31,** | ** ** |
|---------------------------------|------------|--------------------------------------------------|------------|
| ** **                      | ** ** | **2007**                                         | ** ** | **%  Increase  (Decrease)  Over  2006** | ** ** | **2006** | ** ** |
| Domestic (by  U.S. Distributor) |       | 452                                              |       | (8 | )% | 491 |   |
| International                   |       | 5                                                |       | (67 | ) | 15 |   |
| Total                           |       | 457                                              |       | (10 | )% | 506 |   |

 

In addition to the impact of the transitionfrom Edwards to Novadaq, which we believe impacted kit shipments in the firstquarter of 2007, webelieve TMR kit shipments in recent years have largely been affected by what webelieve is an ongoing downward trend in the number of bypass surgeries beingperformed. We believe the proliferation in the number of interventional cardiacprocedures being performed, particularly with the recent advent in the use ofdrug eluting stents, is causing a delay in the number of patients beingreferred to cardiac surgeons for treatment of their cardiovascular disease.Because a significant number of the total TMR procedures performed each year bycardiac surgeons are done in combination with bypass surgery, we believe thegrowth in the number of TMR procedures may be being adversely impacted by thisreduction in the number of bypass surgeries being performed.

**Liquidity and Capital Resources**

Cash, cash equivalents and short-term investments totaled $10,077,000as of March 31, 2007, an increase of $43,000 from $10,034,000 as of December31, 2006.  We have no debt obligations.We believe that our existing cash resources will meet our working capitalrequirements through at least the next 12 months.

Cash provided by operating activities in the threemonths ended March 31, 2007 was $43,000 due to favorable working capitalchanges as well as non-cash depreciation and amortization and compensationrelated to stock options, partially offset by our net loss.  We used $3,000 for the purchase ofequipment.  Additional cash of $3,000 wasprovided by the effect of exchange rate changes.

We will be largely dependenton the future success of Novadaq’s sales and marketing efforts in the U.S. tocontinue to increase the installed base of our second generation Heart LaserSystem, the HL2, and to substantially increase TMR procedural volumes andrevenues. Should the installed base of HL2 lasers or TMR procedural volume notincrease sufficiently, our liquidity and capital resources will be negatively impacted.  Additionally, other unanticipated decreasesin operating revenues or increases in expenses or changes or delays inthird-party reimbursement to healthcare providers using our products mayadversely impact our cash position and require further cost reductions or theneed to obtain additional financing.  Itis not certain that we, working with Novadaq and our internationaldistributors, will be successful in achieving broad commercial acceptance ofthe Heart Laser Systems, or that we will be able to operate profitably in thefuture on a consistent basis, if at all.

Some hospital customers prefer to acquire the Heart Laser Systems on ausage basis rather than as a capital equipment purchase.  We believe this is the result of limitationsmany hospitals 

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currentlyhave on acquiring expensive capital equipment as well as competitive pressuresin the marketplace.  A usage businessmodel will result in a longer recovery period for Novadaq to recoup itsinvestment in lasers it will purchase from us in the future.  This results in (1) a delay in our ability toreceive additional shared revenue, if any, that we otherwise are entitled toreceive under the terms of our new distribution agreement with Novadaq and (2)a potential delay in the purchase of new lasers by Novadaq if the installedbase of lasers placed under usage contracts are under-performing and Novadaqchooses to re-deploy these lasers to other hospital sites in lieu of purchasinga new laser from us.  Our cash positionand our potential need for additional financing to fund operations will bedependent in part upon the number of hospitals that acquire Heart Laser Systemsfrom Novadaq on a usage basis and the number and frequency of TMR proceduresperformed by these hospitals.

Furthermore, we have undertaken a new business strategy that involvesbroadening and diversifying our product portfolio beyond our current offerings,by developing or acquiring new and innovative medical devices to addresscardiac and vascular related markets. Our current and near term developmentefforts in pursuit of this business strategy are focused on performing clinicaltrials of our newest product, RenalGuard. We believe this strategy will result in our incurring losses at least through2008 as we increase our research and development spending in order to conductthe clinical trials that are necessary to obtain the regulatory approval tomarket RenalGuard.  We cannot be certainthat we will be successful in implementing our business strategy or that futuresales, if any, of RenalGuard or other potential new products will recover theinvestments we plan to make. If we are unsuccessful in implementing ourbusiness strategy, or if the diversification of our product portfolio takeslonger or costs more than anticipated, our liquidity and capital resources willbe adversely affected and we may need to obtain additional financing.

There can be no assurancethat, should we require additional financing, such financing will be availableon terms and conditions acceptable to us. Should additional financing not be available on terms and conditionsacceptable to us, additional actions may be required that could adverselyimpact our ability to continue to realize assets and satisfy liabilities in thenormal course of business.  The consolidatedfinancial statements set forth in this report do not include any adjustments toreflect the possible future effects of these uncertainties.

**Off-Balance Sheet Arrangements**

None.

**Item 3.        Quantitativeand Qualitative Disclosures about Market Risk**

A portion of our operations consists of sales activities in foreignjurisdictions.  We manufacture ourproducts exclusively in the U.S. and sell our products in the U.S. and abroad.As a result, our financial results could be affected by factors such as changesin foreign currency exchange rates or weak economic conditions in the foreignmarkets in which we distribute our products. Our operating results are exposed to changes in exchange rates betweenthe U.S. dollar and foreign currencies, especially the Euro. When the U.S.dollar strengthens against the Euro, the value of foreign sales decreases. Whenthe U.S. dollar weakens, the functional currency amount of sales increases. Noassurance can be given that foreign currency fluctuations in the future will notadversely affect our business, financial condition and results of operations,although at present we do not believe that our exposure is significant asinternational sales represented only 3% of our consolidated sales during thethree months ended March 31, 2007 and 8% of our consolidated sales 

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inthe year ended December 31, 2006. We do not hedge any balance sheet exposuresand intercompany balances against future movements in foreign exchange rates.

Our interest income and expense are sensitive tochanges in the general level of U.S. and foreign interest rates. In thisregard, changes in U.S. and foreign interest rates affect the interest earnedon our cash and cash equivalents.  We donot believe that a 10% change to the applicable interest rates would have amaterial impact on our future results of operations or cash flows.

## **Item 4.        Controls andProcedures**

Our management, with the participation of our chief executive officerand chief financial officer, evaluated the effectiveness of our disclosurecontrols and procedures as of March 31, 2007. The term “disclosure controls and procedures”, as defined in Rules13a-15(e) and 15d-15(e) under the Exchange Act, means controls and otherprocedures of a company that are designed to ensure that information requiredto be disclosed by a company in the reports that it files or submits under theExchange Act is recorded, processed, summarized and reported within the timeperiods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controlsand procedures designed to ensure that information required to be disclosed bya company in the reports that it files or submits under the Exchange Act isaccumulated and communicated to the company’s management, including its principalexecutive and principal financial officers, as appropriate to allow timelydecisions regarding required disclosure. Management recognizes that any controls and procedures, no matter howwell designed and operated, can provide only reasonable assurance of achievingtheir objectives and management necessarily applies its judgment in evaluatingthe cost-benefit relationship of possible controls and procedures.  Based on the evaluation of our disclosurecontrols and procedures as of March 31, 2007, our chief executive officer andchief financial officer concluded that, as of such date, our disclosurecontrols and procedures were effective at the reasonable assurance level.

No change in our internal control over financial reporting (as definedin Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during thefiscal quarter ended March 31, 2007 that has materially affected, or isreasonably likely to materially affect, our internal control over financialreporting.

**Part II.  Other Information**

**Item 1A.       Risk Factors**

The risks and uncertainties described below are notthe only risks we face.  Additional risksand uncertainties not presently known to us or currently deemed immaterial mayalso impair our business operations.  Ifany of the following risks actually occur, our financial condition andoperating results could be materially adversely affected.

***We expect to incur significant operating losses in the near future.***

We expect to incur netlosses in future quarters, at least through 2008, as we increase our researchand development on clinical studies of RenalGuard. We cannot provide anyassurance that we will be successful with our business strategy, thatRenalGuard will receive FDA approval or commercial acceptance, or that we willever return to profitability.

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***Our new distributor for TMR products in the U.S. has only recentlybegun building a direct sales and marketing organization.***

Priorto December 2006, Novadaq employed 12 clinical educators who assisted anindependent distributor, CarboMedics, to drive sales and product adoption oftheir SPY Imaging System. In December 2006, Novadaq announced they hadterminated their distribution arrangement with CarboMedics and had hired anadditional 12 sales representatives to work with their existing clinicaleducators and to begin the process of establishing a dedicated direct salesorganization. Novadaq has continued to hire additional sales and marketingprofessionals and their direct sales organization, including clinicaleducators, now numbers 30 people in total.

Novadaqfaces all the normal challenges inherent in building and sustaining aneffective direct sales and marketing organization, including, but not limitedto:

·                  Attracting, training and retaining a sufficient number of qualifiedindividuals with the requisite sales and management experience to effectivelymarket their products throughout the United States;

·                  Developing, implementing and monitoring compliance with a broad arrayof new sales policies and procedures that ensure sales practices are carriedout in a manner consistent with management’s expectations;

·                  Employing effective marketing programs that maximize the revenuepotential of their products;

·                  Securing the requisite financial resources to broadly and effectivelyimplement their sales and marketing strategies;

·                  Successfully transitioning an existing customer base with priorloyalties to Edwards in a manner that minimizes disruption to current revenuestreams; and

·                  Building a recognized brand name and industry awareness of PLC and ourproducts.

Tothe extent Novadaq or its management team is unsuccessful in achieving any orall of these organizational objectives, our sales of TMR products in the U.S.may suffer and our business, financial condition and results of operations maybe seriously harmed.

***Our company iscurrently dependent on one principal customer.***

Pursuant to the terms of ournew TMR distribution agreement with Novadaq, Novadaq is our exclusivedistributor for our HL2 TMR laser and TMR kits in the United States.  As a result of this exclusive arrangement,Novadaq has become our principal customer, just as Edwards was our principalcustomer prior to the assignment of the distribution rights.

Our U.S. distributoraccounted for 82% and 88% of total revenues in the three months ended March 31,2007 and the year ended December 31, 2006, respectively.  As a result of this expected concentration ofsales with one customer, we bear an increased financial risk of timely salescollection if for any reason Novadaq’s business condition should suffer. Inaddition, if our relationship with Novadaq does not progress as anticipated, orif Novadaq’s sales and marketing 

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strategies fail to generate sales of our products inthe future, our revenue will decrease significantly and our business, financialcondition and results of operations will be seriously harmed.

***Our company is currently dependent on one principal product line togenerate revenues.***

We currently sell oneprincipal product line, the Heart Laser Systems, which accounts for the majorityof our total revenues.  Approximately 78%and 95% of our revenues in the three months ended March 31, 2007 and the yearended December 31, 2006, respectively, were derived from the sales and serviceof our Heart Laser Systems.  This absenceof a diversified product line means that we are directly and materiallyimpacted by changes in the market for Heart Laser Systems.

***Our company isdependent on certain suppliers.***

Some of the components for our Heart Laser Systems, most notably thepower supply and certain optics and fabricated parts for the HL2, are onlyavailable from one supplier, and we have no assurance that we will be able tosource any of our sole-sourced components from additional suppliers.  We are dependent upon our sole suppliers toperform their obligations in a timely manner. In the past, we have experienced delays in product delivery from oursole suppliers and, because we do not have an alternative supplier to producethese products for us, we have little leverage to enforce timely delivery. Anydelay in product delivery or other interruption in supply from these supplierscould prevent us from meeting our commercial demands for our products, whichcould have a material adverse effect on our business, financial condition andresults of operations.  Furthermore, wedo not require significant quantities of any components because we produce alimited number of our products each year. Our low-quantity needs may not generate substantial revenue for oursuppliers.  Therefore, it may be difficultfor us to continue our relationships with our current suppliers or establishrelationships with additional suppliers on commercially reasonable terms, if atall, and such difficulties may seriously harm our business, financial conditionand results of operations.

***We are dependent upon our key personnel andwill need to hire additional key personnel in the near future.***

Our ability to operate ourbusiness successfully depends in significant part upon the retention andmotivation of certain key technical, regulatory, production and managerialpersonnel and consultants and our ongoing ability to hire and retain additionalqualified personnel in these areas. Competition for such personnel is intense,particularly in the Greater Boston area. We cannot be certain that we will beable to attract such personnel and the loss of any of our current key employeesor consultants could have a significant adverse impact on our business.

***Our company may be unable to raise neededfunds.***

As of March 31, 2007, we hadcash and cash equivalents totaling $10,077,000. Based on our current operatingplan, we anticipate that our existing capital resources should be sufficient tomeet our working capital requirements for at least the next 12 months; however,we may need to raise additional funds in the future.  We may not be able to raise additionalcapital upon satisfactory terms, or at all, and our business, financialcondition and results of operations could 

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be materially and adversely affected.  To the extent that we raise additionalcapital by issuing equity or convertible securities, ownership dilution to ourshareholders will result.  To the extentthat we raise additional capital through the incurrence of debt, our activitiesmay be restricted by the repayment obligations and other restrictive covenantsrelated to the debt.

***In order to compete effectively, our current and future products needto gain commercial acceptance.***

Our current TMR products maynever achieve widespread commercial acceptance. To be successful, we and Novadaq need to:

·                  demonstrate to the medical community ingeneral, and to heart surgeons and cardiologists in particular, that TMRprocedures are effective, relatively safe and cost effective;

·                  support third-party efforts to document themedical processes by which TMR procedures relieve angina;

·                  have more heart surgeons trained to performTMR procedures using the Heart Laser Systems; and

·                  maintain and expand third-party reimbursementfor the TMR procedure.

To date, only a limitednumber of heart surgeons have been trained in the use of TMR using the HeartLaser Systems.  We are dependent onNovadaq to expand related marketing and training efforts in the U.S. for theuse of our products.

The Heart Laser Systems havenot yet received widespread commercial acceptance.  We believe that concerns over the lack of aconsensus view on the reason or reasons why a TMR procedure relieves angina inpatients who undergo the procedure has limited demand for and use of the HeartLaser Systems. Until there is consensus, if ever, of the medical processes bywhich TMR procedures relieve angina, we believe some hospitals will delay theimplementation of a TMR program.

If we are unable to achievewidespread commercial acceptance of the Heart Laser Systems, our business,financial condition and results of operations will be materially and adverselyaffected.

***Our newest product, RenalGuard, is still undergoing development and wehave only recently begun to test it in a clinical setting as part of ourinitial pilot clinical study.***

We have only recently completed the first generationproduct design for our RenalGuard System and we have just begun testing thedevice in a clinical hospital setting as part of our pilot human clinicalstudy. We may need to make substantial modifications to the design, features orfunctions of our device in order for it to obtain FDA approval or meet customerexpectations. These changes may not be able to be completed in a timelyfashion, if at all. Should any such modifications prove to be significantly morecostly or time consuming to engineer than we estimate, our ability to bringthis product to market may be severely and negatively impacted.

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***Our planned future clinical trials to study the safety andeffectiveness of RenalGuard in preventing contrast-induced nephropathy willtake us a significant amount of time to complete, if we can complete them atall, and the results of these clinical trials may not show sufficient safetyand efficacy for us to either obtain FDA approval or otherwise be able to successfullymarket and sell the product.***

Ourbusiness strategy to grow our revenues and profitability is largely dependenton our success in timely completing our planned future clinical trials ofRenalGuard. We hope to be able to demonstrate through clinical trials thatRenalGuard is safe and effective in preventing CIN, a form of acute renalfailure caused by exposure to contrast media for patients undergoing imagingprocedures.

We can provide no assurance that when studied inhumans, RenalGuard will be shown to be safe or effective in preventing CIN, orthat the degree of any positive safety and efficacy results will be sufficientto either obtain FDA approval or otherwise successfully market our product.Furthermore, the completion of our planned clinical trials is dependent uponmany factors, some of which are not entirely within our control, including, butnot limited to, our ability to successfully recruit investigators, theavailability of patients meeting the inclusion criteria of our clinical study,the competition for these particular study patients amongst other clinicaltrials being conducted by other companies at these same study sites, theability of the sites participating in our study to successfully enroll patientsin our trial, and proper data gathering on the part of the investigating sites.

Should our clinical trialstake longer than we expect, our competitive position relative to existingpreventative measures, or relative to new devices, drugs or therapies that maybe developed, could be seriously harmed and our ability to successfully fundthe completion of the trials and bring RenalGuard to market may be adverselyaffected.

***We will need to build a direct sales and marketing organization orotherwise enter into one or more distribution arrangements in order to marketour RenalGuard System if and when it is approved for sale.***

We currently do not have a direct sales force.Instead, we market our existing TMR products through Novadaq in the UnitedStates and through independent distributors outside the U.S.  We do not plan to use Novadaq to market ourRenalGuard System if and when it becomes commercially available to customers.We will need to either build an internal direct sales and marketing organizationor find distribution partners in order to successfully market our RenalGuardSystem.

If we choose to build a direct sales force, we maynot be able to attract qualified individuals with the requisite training orexperience to sell our product. In addition, we would need to devotesubstantial management time instituting policies, procedures and controls tooversee and effectively manage this new part of our organization, which couldadversely impact our daily operations and would require us to investsignificant financial resources, the cost of which could be prohibitive.

If we instead choose to pursue an indirectdistribution strategy, we may not be able to identify suitable distributionpartners with sufficient industry experience, brand recognition, sales capacityand willingness/ability to maximize sales. Further, we may not be able tonegotiate

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distribution agreements with terms and conditions that are acceptableto us, including ensuring that our product receives adequate sales force focusand attention.

***Our primarycompetitor in TMR may obtain FDA approval to market a new device, the impact ofwhich is uncertain on the future adoption rate of TMR.***

Our primary TMR competitor, CardioGenesis, hasattempted in the past and may attempt in the future to obtain FDA approval tomarket their “percutaneous” method of performing myocardial revascularization,previously known as PMR, and recently rebranded as PMC (percutaneous myocardialchanneling), which would provide a less invasive method of creating channels inthe heart.  If PMC can be shown to be safe and effective and is approvedby the FDA, it would eliminate the need in certain patients to make an incisionin the chest, reducing costs and speeding recovery.  It is unclear what impact, if any, approvalof a PMC device would have on the future adoption rate for TMR procedures. IfPMC is approved, it could erode the potential TMR market, which would have amaterial adverse effect on our business, financial condition and results ofoperations.

***Rapid technological changes in our industry could make our productsobsolete.***

Our industry ischaracterized by rapid technological change and intense competition.  New technologies and products and newindustry standards will develop at a rapid pace, which could make our currentand future planned products obsolete. The advent of new devices and proceduresand advances in new drugs and genetic engineering are especially concerningcompetitive threats.  Our future successwill depend upon our ability to develop and introduce product enhancements toaddress the needs of our customers. Material delays in introducing product enhancements may cause customersto forego purchases of our products and purchase those of our competitors.

Many potential competitorshave substantially greater financial resources and are in a better financialposition to exploit marketing and research and development opportunities.

***We must receive and maintain government clearances or approvals inorder to market our products.***

Our products and ourmanufacturing activities are subject to extensive, rigorous and changingfederal and state regulation in the U.S. and to similar regulatory requirementsin other major international markets, including the European Union andJapan.  These regulations and regulatoryrequirements are broad in scope and govern, among other things:

·                  product design and development;

·                  product testing;

·                  product labeling;

·                  product storage;

·                  premarket clearance and approval;

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·                  advertising and promotion; and

·                  product sales and distribution.

Furthermore, regulatoryauthorities subject a marketed product, its manufacturer and the manufacturingfacilities to continual review and periodic inspections.  We are subject to ongoing FDA requirements,including required submissions of safety and other post-market information andreports, registration requirements, Quality Systems regulations, andrecordkeeping requirements. The FDA’s Quality Systems regulations includerequirements relating to quality control and quality assurance, as well as thecorresponding maintenance of records and documentation.  Depending on its activities, Novadaq may alsobe subject to certain requirements under the U.S. Food, Drug, and Cosmetic Actand the regulations promulgated thereunder, and state laws and registrationrequirements covering the distribution of our products. Regulatory agencies maychange existing requirements or adopt new requirements or policies that couldaffect our regulatory responsibilities or the regulatory responsibilities of adistributor like Novadaq.  We may be slowto adapt or may not be able to adapt to these changes or new requirements.

Later discovery ofpreviously unknown problems with our products, manufacturing processes, or ourfailure to comply with applicable regulatory requirements may result inenforcement actions by the FDA and other international regulatory authorities,including, but not limited to:

·                  warning letters;

·                  patient or physician notification;

·                  restrictions on our products or manufacturingprocesses;

·                  voluntary or mandatory recalls;

·                  product seizures;

·                  refusal to approve pending applications orsupplements to approved applications that we submit;

·                  refusal to permit the import or export of ourproducts;

·                  fines;

·                  injunctions;

·                  suspension or withdrawal of marketingapprovals or clearances; and

·                  civil and criminal penalties.

Should any of theseenforcement actions occur, our business, financial condition and results ofoperations could be materially and adversely affected.

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To date, we have receivedthe following regulatory approvals for our products:

***Heart Laser Systems***

*UnitedStates —*We receivedFDA approval to market the HL1 Heart Laser System in August 1998 and the HL2Heart Laser System in January 2001. However, although we have received FDA approval, the FDA:

·                  has restricted the use of the Heart LaserSystems by not allowing us to market these products to treat patients whosecondition is amenable to conventional treatments, such as heart bypass surgery,stenting and angioplasty; and

·                  could impose additional restrictions orreverse its ruling and prohibit use of the Heart Laser Systems at any time.

In addition, as a conditionof our original FDA approval for our TMR products, we were required by the FDAto perform a postmarket surveillance study. The FDA recently requested that wesubmit a PMA Postapproval Study report summarizing this postmarket surveillancestudy. As part of this report, the FDA requested that we analyze and discussthe adverse event and mortality rates seen in the postmarket study and comparethese results to the premarket study which was presented as part of our initialFDA PMA application. We filed this postapproval study report with the FDA onFebruary 28, 2007.

Because of the significantsafety information collected in the postapproval study, and as the FDA hasindicated it plans to do in other product areas, we believe that the FDA plansto present the results at a future meeting of the FDA Circulatory SystemDevices Advisory Panel and thereafter determine what, if any, actions should betaken with respect to our current Heart Laser Systems PMA.

*Europe —*We received the CE Mark from the EuropeanUnion for the HL1 and HL2 in March 1995 and February 2001, respectively.  However:

·                  the European Union could impose additionalrestrictions or reverse its ruling and prohibit use of the Heart Laser Systemsat any time; and

·                  France has prohibited, and other EuropeanUnion countries could prohibit or restrict, use of the Heart Laser Systems.

*Japan —*Our HL1 Heart Laser System received marketingapproval from the Japanese Ministry of Health, Labor and Welfare (“MHLW”) inMay 2006. However, the MHLW could impose restrictions in the future or reverseits ruling and prohibit use of the Heart Laser Systems at any time.

In addition, it is unclearwhat impact the introduction of the HL2 into the U.S. and other internationalmarkets will have on the ability of our Japanese distributor to market ourolder, first generation HL1 in Japan. Although our Japanese distributor hasindicated to us that it plans to seek MHLW approval in the future to market ournewer HL2, we can provide no assurance that the distributor will be successfulin obtaining the necessary approvals or how long it may take to secure therequired approvals.

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***RenalGuard***

We presently have nogovernmental approvals to market our RenalGuard System. We must receive eitherFDA approval or clearance before we can market our product in the UnitedStates. We must also receive CE Mark approval before we can market our productin the EU. Other countries may require their own approvals prior to our beingable to market our product in those countries.

The process of obtaining andmaintaining regulatory approvals and clearances to market a medical device canbe costly and time consuming, and we cannot predict when, if ever, suchapprovals or clearances will be granted. Pursuant to FDA regulations, unlessexempt, the FDA permits commercial distribution of a new medical device onlyafter the device has received 510(k) clearance or is the subject of an approvedPMA application. The FDA will clear marketing of a medical device through the510(k) process only if it is demonstrated that the new product is substantiallyequivalent to other 510(k)-cleared products.

At the present time we arenot aware of any clear predicates with substantially the same proposedindications for use which would enable us to conclude that RenalGuard is likelyto be cleared by the FDA as a 510(k) device. Therefore, we believe RenalGuardmost likely will need to go through the PMA application process.

Because the PMA applicationprocess is more costly, lengthy and uncertain than the 510(k) process and mustbe supported by extensive data, including data from preclinical studies andhuman clinical trials, we cannot predict when our product may eventually cometo market. Should we be unable to obtain FDA or CE Mark approval for RenalGuard,or should the approval process take longer than we anticipate, our futurerevenue growth prospects could be materially and adversely affected.

***Changes in third party reimbursementfor TMR procedures or our inability to obtain third party reimbursement forRenalGuard could materially affect future demand for our products.***

Demand for medical devices is often affected by whether third partyreimbursement is available for the devices and related procedures.  Currently Medicare coverage is provided forTMR when it is performed as a sole therapy treatment.  In addition, when two or more medicalprocedures are performed in combination with each other, Medicare rulesgenerally allow hospitals to bill for whichever of the two procedures carriesthe higher reimbursement amount. Therefore, in situations where sole therapyTMR reimbursement rates exceed that provided for bypass surgery alone, ifhospitals perform a combination procedure where both bypass surgery andadjunctive TMR are performed on a patient, the hospital is able to bill for thehigher TMR procedure reimbursement payment. In these instances, the doctor alsocan bill an additional amount for performing multiple procedures.

Certain private insurance companies and health maintenanceorganizations also currently provide reimbursement for TMR procedures performedwith our products and physician reimbursement codes have been established forboth surgical procedures.

No assurance can be given, however, that thesepayers will continue to reimburse healthcare providers who perform TMRprocedures using our products now or in the future.  

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Further, no assurance can be given that additional payers willreimburse healthcare providers who perform TMR procedures using our products orthat reimbursement, if provided, will be timely or adequate.

Should third party insurance reimbursement for TMRprocedures be reduced or eliminated in the future, our business, financialcondition and results of operations would be materially and adversely affected.

Furthermore, we know of no existing Medicarecoverage or other third party reimbursement that would be available to eitherhospitals or physicians that would help defray the additional cost that wouldresult from the future purchase and/or use of our RenalGuard System. We also canprovide no assurance that we will ever be able to obtain Medicare coverage orother third party reimbursement for the use of RenalGuard, which couldmaterially and adversely affect the potential future demand for this product.

In addition, the market for our all our productscould be adversely affected by future legislation to reform the nation’shealthcare system or by changes in industry practices regarding reimbursementpolicies and procedures.

***Securing intellectual property rights for our RenalGuard System iscritical to our future business plans, but may prove to be difficult orimpossible for us to obtain.***

We have filed seven patent applications and have oneprovisional patent application pending at the United States patent officerelated to our RenalGuard System, RenalGuard Therapy and other intellectualproperty in the general field of preventing contrast-induced nephropathy andacute renal failure. Securing patent protection over our intellectual propertyideas in this field is, we believe, critical to our plans to successfullydifferentiate and market our RenalGuard System and grow our future revenues. Wecan provide no assurance, however, that we will be successful in securing anypatent protection for our intellectual property ideas in this chosen field orthat our efforts to obtain patent protection will not prove more difficult, andtherefore more costly, than we are otherwise expecting. Furthermore, even if weare successful in securing patent protection for some or all of ourintellectual property ideas in this field, we cannot predict when in the futureany such potential patents may be issued, how strong such patent protectionwill prove to be, or whether these patents will be issued in a timely enoughfashion to afford us any commercially meaningful advantage in marketing ourRenalGuard System against other potentially competitive devices.

***Asserting and defending intellectual property rights may impact ourresults of operations.***

In our industry, competitorsoften assert intellectual property infringement claims against oneanother.  The success of our businessdepends on our ability to successfully defend our intellectual property.  Future litigation may have a material impacton our financial condition even if we are successful in marketing our products.We may not be successful in defending or asserting our intellectual propertyrights.

An adverse outcome in anylitigation or interference proceeding could subject us to significantliabilities to third parties and require us to cease using the technology thatis at issue or to license the technology from third parties.  In addition, a finding that any of ourintellectual 

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property is invalid could allow our competitors tomore easily and cost-effectively compete with us.  Thus, an unfavorable outcome in any patentlitigation or interference proceeding could have a material adverse effect onour business, financial condition or results of operations.

The cost to us of any patentlitigation or interference proceeding could be substantial.  Uncertainties resulting from the initiationand continuation of patent litigation or interference proceedings could have amaterial adverse effect on our ability to compete in the marketplace.  Patent litigation and interferenceproceedings may also absorb significant management time.

***We may be subject to product liability lawsuits; our insurance may notbe sufficient to cover damages.***

We may be subject to productliability claims.  Such claims may absorbsignificant management time and could degrade our reputation and themarketability of our products.  Ifproduct liability claims are made with respect to our products, we may need torecall the implicated product which could have a material adverse effect on ourbusiness, financial condition and results of operations. In addition, althoughwe maintain product liability insurance, we cannot be sure that our insurancewill be adequate to cover potential product liability lawsuits. Our insuranceis expensive and in the future may not be available on acceptable terms, if atall. If a successful product liability claim or series of claims exceeds ourinsurance coverage, it could have a material adverse effect on our business,financial condition and results of operations.

***We are subject to risks associated with international operations.***

A portion of our productsales are generated from operations outside of the U.S.  Establishing, maintaining and expandinginternational sales can be expensive. Managing and overseeing foreign operations are difficult and productsmay not receive market acceptance.  Risksof doing business outside the U.S. include, but are not limited to, thefollowing: agreements may be difficult to enforce and receivables difficult tocollect through a foreign country’s legal system; foreign customers may havelonger payment cycles; foreign countries may impose additional withholdingtaxes or otherwise tax our foreign income, impose tariffs or adopt otherrestrictions on foreign trade; U.S. export licenses may be difficult to obtain;and the protection of intellectual property rights in foreign countries may bemore difficult to enforce.  There can beno assurance that our international business will grow or that any of theforegoing risks will not result in a material adverse effect on our business orresults of operations.

***We will soonhave to comply with requirements regarding internal control over financialreporting.***

Pursuant to Section 404 of the Sarbanes-Oxley Act of2002, beginning with our fiscal year ending December 31, 2007, our managementwill be required to provide a report on the effectiveness of our internalcontrol over financial reporting.  We aredeveloping a program to perform this evaluation in order to comply with theserequirements.  Compliance with theserequirements is expected to be expensive and time-consuming.  If we fail to timely complete thisevaluation, we could be subject to regulatory action and public confidence inus could be adversely affected and our stock price could decline.  In addition, any failure to implementrequired new or improved controls, or difficulties encountered in theirimplementation, could harm our operating results or cause us to fail to meetour reporting obligations.

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***Because we are incorporated in Canada, you may not be able to enforcejudgments against us and our Canadian directors.***

Under Canadian law, you maynot be able to enforce a judgment issued by courts in the U.S. against us orour Canadian directors. The status of the law in Canada is unclear as towhether a U.S. citizen can enforce a judgment from a U.S. court in Canada forviolations of U.S. securities laws. A separate suit may need to be broughtdirectly in Canada.

***Our stock price has historically fluctuatedand may continue to fluctuate significantly in the future which may result inlosses for our investors.***

Our stock price has been andmay continue to be volatile. Some of the factors that can affect our stockprice are:

·                  the announcement of new products, services ortechnological innovations by us or our competitors;

·                  actual or anticipated quarterly increases ordecreases in revenue, gross margin or earnings, and changes in our business,operations or prospects;

·                  speculation or actual news announcements inthe media or industry trade journals about our company, our products, the TMRor CIN prevention procedures or changes in reimbursement policies by Medicareand/or private insurance companies;

·                  announcements relating to strategicrelationships or mergers;

·                  conditions or trends in the medical deviceindustry;

·                  changes in the economic performance or marketvaluations of other medical device companies; and

·                  general market conditions or domestic orinternational macroeconomic and geopolitical factors unrelated to ourperformance.

***The market price of our stock may fall if shareholders sell theirstock.***

Certain current shareholders, including Edwards,hold large amounts of our stock, which they could sell in the public marketfrom time to time.  Sales of asubstantial number of shares of our common stock within a short period of timecould cause our stock price to fall.  Inaddition, the sale of these shares could impair our ability to raise capitalthrough the sale of additional stock.

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**Item 6.            Exhibits**

| 10.1   | +      | Distribution  Agreement, dated March 20, 2007, by and among the Registrant, PLC Medical  Systems, Inc., Novadaq Technologies Inc. and Novadaq Corp.                                                    |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                   |
| 10.2   |   | Letter  Agreement, dated March 20, 2007, by and among the Registrant, PLC Medical  Systems, Inc. and Edwards Lifesciences LLC.                                                                         |
|   |   |                                                                                                                                                                                                   |
| 31.1   |   | Certification of  Chief Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the  Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002. |
|   |   |                                                                                                                                                                                                   |
| 31.2   |   | Certification of  Chief Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the  Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002. |
|   |   |                                                                                                                                                                                                   |
| 32.1   |   | Certifications  pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                                                                             |
|   |   |                                                                                                                                                                                                   |
|   | +      | Confidential  treatment requested as to certain portions, which portions have been omitted  and filed separately with the Securities and Exchange Commission.                                          |

 

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**SIGNATURES**

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.
|                    |   | PLC SYSTEMS INC. |
|--------------------|--------|------------------|
|               |   |             |   |   |
| Date: May 15, 2007 |   | By:              |   | /s/ James G. Thomasch |   |
|               |   |             |   | James G. Thomasch |
|               |   |             |   | Chief Financial Officer   (Principal Financial Officer and Chief   Accounting Officer) |

 

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**EXHIBITINDEX**
| Exhibit  Number | ** ** | **Description of Document**                                                                                                                                                                      |
|-----------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **      |       |                                                                                                                                                                                             |
| 10.1            | +          | Distribution Agreement, dated March 20, 2007, by and  among the Registrant, PLC Medical Systems, Inc., Novadaq Technologies Inc.  and Novadaq Corp.                                              |
|            |       |                                                                                                                                                                                             |
| 10.2            |       | Letter Agreement, dated March 20, 2007, by and among  the Registrant, PLC Medical Systems, Inc. and Edwards Lifesciences LLC.                                                                    |
|            |       |                                                                                                                                                                                             |
| 31.1            |       | Certification of Chief Executive Officer pursuant to  Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as  adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
|            |       |                                                                                                                                                                                             |
| 31.2            |       | Certification of Chief Financial Officer pursuant to  Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as  adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
|            |       |                                                                                                                                                                                             |
| 32.1            |       | Certifications pursuant to 18 U.S.C. Section 1350,  as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                        |
|            |       |                                                                                                                                                                                             |
|            | +          | Confidential treatment requested as to certain  portions, which portions have been omitted and filed separately with the  Securities and Exchange Commission.                                    |

 

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